You might be wondering why rich central bankers remain unrelenting in their desire to raise interest rates. After all, there are plenty of signs individual components of inflation are rolling over.
Given each interest rate hike takes at least six months to have an affect on slowing the economy, the Federal Reserve could easily over tighten, thereby worsening the recession.
American central bankers have the dual goal of maintaining maximum employment and stabilizing inflation. When the labor market is robust, there tends to be inflationary pressure and vice versa.
The NAIRU (Non-Accelerating Inflation Rate of Unemployment) is an estimate of the lowest the unemployment rate can go without leading to rising inflation.
In an ideal scenario, the Federal Reserve would like to see an unemployment rate of between 4%- 5% and an inflation rate of between 2%-3%. In other words, the NAIRU is around 4%, but it changes with the times.
Historically, the Fed has had an inflation rate target of 2%. However, based on where inflation is today, I’m sure they’d be happy if we got to 3%.
The Central Bank’s Role And The Power Of Moral Suasion
An important policy strategy is using moral suasion to get consumers and investors to do what rich central bankers want. Moral suasion is the act of persuading a person or group to act in a certain way through rhetorical appeals, persuasion, or implicit and explicit threats—as opposed to the use of outright coercion or physical force.
For example, even if rich central bankers believe inflation has peaked and is heading down, they won’t verbalize their beliefs to the public. Because if they do, the public may end up hiring, buying, and investing aggressively again in anticipation the central bank will slow its rate hikes or cut rates in the future. If this happens, it neutralizes the deflationary effects of the central bank’s rate hikes, thereby extending higher inflation for a longer period.
Rich central bankers are very similar to politicians in that they have a proclivity to say one thing and do another. However, unlike politicians, the effectiveness of a central banker’s actions can be more easily measured given both the unemployment and inflation rates are easily tracked.
The farther away the unemployment rate is from 4%-5% and the inflation rate is from 2%-3%, the more the central bank is failing. Instead of creating soft landing scenarios, the central bank is orchestrating boom-bust scenarios. And during boom-bust scenarios, more people suffer.
Ideally, we want the peaks and troughs of a business cycle to be as close to the long-run real GDP trend as possible. This way, citizens can better plan their future.
Wealthy Fed Board Of Governors
Now that we understand central bankers can’t always speak the truth or speak clearly to the public (Alan Greenspan was famous for nonsensical jibber jabber), let’s try to understand how central bankers think.
Jerome Powell, makes $203,500, while other Board members make $183,100, amounts set by Congress. In America, these are top 15% salaries. However, their salaries are not too meaningful as all of them are wealthy.
Our seven Board of Governors of the Federal Reserve are already rich. Fed Chair Jerome Powell was a partner at The Carlye Group, a private equity powerhouse. His net worth is easily over $50 million, and more likely over $100 million.
When you are worth tens of millions of dollars, you are obviously financially secure. No matter how poorly the economy performs, you and your family will likely still be fine. You do not need a day job to live a good life. You already have enough assets to generate a large sum of passive investment income.
Further, once you have mega millions, unless you’re extremely greedy, your focus shifts more towards service and legacy. Do not underestimate the importance of legacy to a wealthy person.
Legacy is why billionaires donate massive amounts of money to colleges to get a building named after them. Even though these colleges have huge endowments and continue to charge exorbitant tuition rates, some of the richest people can’t help but lust after status and legacy.
Banning Of Trading Securities By The Federal Reserve Board
In addition to already being rich, the Board of Governors had another tantalizing advantage other investors did not. It was the ability to trade securities before they made policy statements and decisions.
After many years of public complaining, starting May 1, 2022, members of the Federal Reserve may no longer trade affected stocks beforehand and front-run their decisions. As a result, the opportunity to make millions from this form of insider knowledge has vanished.
The rules “aim to support public confidence in the impartiality and integrity of the Committee’s work by guarding against even the appearance of any conflict of interest,” a statement by the Fed said.
No matter how rich you become, however, it’s hard to suppress the allure of making money in a way most others cannot. This is the combination of greed and the thrill of being able to get away with a wrongdoing. When you have power, you sometimes feel very special.
For example, Galleon hedge fund manager Raj Rajarathnam was worth billions. Yet, he was still willing to trade on insider information provided to him by his pal at McKinsey. You would think the risk of going to jail for 10+ years would be enough to deter such illegal activity.
Trying to get away with something illegal can be intoxicating. At a certain level of wealth, you sometimes believe you are above the law.
The irony is, as investors, it was probably preferable for the Board of Governors to continue to be allowed to trade on insider information. This way, the Governors would be more incentivized to adopt polices that boosted their multi-million dollar investment positions!
Just look at how various American stock indices have performed since the proposed ban was announced at the end of 2021. Since the beginning of 2022, the various stock markets have all gone down. Coincidence? I don’t think so.
Status Increases If You Hit Your Target Objectives
With no incentive to make money via trading, the Federal Reserve Board of Governors is now focussing on status. Its status in the history books will increase if it can get inflation back down to 2-3% without causing the unemployment rate to go up beyond 5%.
Right now, the Board of Governors has mediocre status. In 2020 and 2021, it cut rates too aggressively and unleashed too much liquidity in 2020 and 2021. Partially due to these decisions, inflation spiraled to 40-year highs.
Now, the Board of Governors wants to rectify its mistakes. It doesn’t want to be viewed as the reason for causing so much inflation. But this time, without millions of dollars of personal investments at stake to moderate its decisions, it can now raise rates as aggressively as it wants to and tank the economy and force inflation down.
Central Bankers Can Outperform In A Worsening Economy
As the stock market and housing market decline, the Board of Governors and 3,000+ Fed agency employees get relatively wealthier. They’ve got less exposure to risk assets and more cash.
Further, working for the Federal Reserve is a much safer job than working in the private sector. As more private sector jobs are lost due to a recession, employees at the Federal Reserve outperform.
When you don’t have as much skin in the game, you naturally don’t care as much.
I know what I’ve written sounds a little cynical, but this is the reality of the world. As long as monetary policy and government policy are run by people, there will always be policy errors. It is very hard for anybody to overcome greed, fear, and the desire for status.
If central bankers were not rich, but mostly made up of middle-class people, perhaps their decisions would be more moderate. Maybe, middle-class central bankers would be more empathetic to the majority of Americans who rely on jobs to survive.
But if you’re rich enough where you don’t have to work, and narcissistic enough to want a top government job, then you may not care so much about the middle class. Instead, you’re more focused on your legacy.
If the Federal Reserve doesn’t relent on its rate hikes by the end of 2022, the recession will likely deepen. And because I believe the Board of Governors care about their legacy the most, they will likely become more dovish in 2023. But in case they don’t, you need to raise your cash hoard.
The more cash you have in a deepening recession, the better you will feel. And as more assets sell at bargain-basement prices, you can swoop in and take advantage of the Fed-induced carnage.
The Federal Reserve Is Struggling To Govern Properly
If it isn’t clear by now, it is dangerous to depend on the government or an individual to survive. You must depend on yourself. Politicians have their own agendas. Further, the good graces of an individual will unlikely last forever.
The Federal Reserve literally employs ~400 PhDs and has over 20,000 employees with an annual payroll of over $2.578 BILLION. Yet they still can’t properly manage price stability. Maybe economics is a harder topic than it seems. Or maybe the Federal Reserve is bloated.
Whatever the case may be, don’t fight the Fed and also don’t believe the Fed will make the right decisions. If they really hike the Fed Funds rate to 4% as inflation comes down, we are going to experience an intense recession.
Depend On Nobody Else But Yourself To Survive
Focus on boosting your cash flow to weather the storm. It is more important than a subjective net worth. No matter how well you do at your job or how much market share your company takes, an unrelenting Fed will break the correlation between effort and reward.
As I’ve recommended in my book, Buy This, Not That, follow an appropriate net worth asset allocation model for your age and risk tolerance. The key is to stick with the framework until the good times eventually return. In the meantime, if you need a job to survive, build your relationships with those who determine your destiny. More layoffs are coming.
Readers, how far do you think the Fed is willing to go to bring inflation back down to 2% – 3%? How much do you think being already rich has to do with how the Fed thinks? Are you raising your cash hoard now, despite inflation still elevated?
Heads up, Personal Capital Cash is offering a cash savings rate of 2.02%. This is one of the highest rates I’ve seen online today.
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